Community Service: Making Room For Smaller Banks

Posted on June 14th, 2013

It was always known that from the moment she was awarded a spot on the Senate Banking Committee, freshman Sen. Elizabeth Warren would be making waves. In the few months since her swearing-in, she’s certainly lived up to her billing: She’s hammered bankers, lobbyists and regulators alike on issues such as home foreclosures, announced an active review of the settlement the government reached with big banks, and called for major changes to gender equity laws. And that’s all in just the past few weeks.

Another recent query, however, may have even greater consequences for the banking industry. During a hearing with the Senate Committee on Banking, Housing and Urban Affairs, she asked a direct question that has perhaps been on many others’ minds: “Are we reaching a point where we should have a two-tiered regulatory system?”

By any definition, this is at least a valid question. Specific subtleties aside, the entire industry is essentially subject to the same set of regulations. However, as the Federal Deposit Insurance Corp. has reported, community banks represented a staggering 95% of all banking organizations in 2011, yet retained only 14% of all banking assets. Incidentally, that figure represents a steep drop—in 1984, the same industry segment held 38% of all U.S. banking assets.

There are other serious discrepancies, too. Despite the dominance of larger banks in this domain, the FDIC revealed that community banks hold the majority of banking deposits in U.S. rural and ‘micropolitan’ counties. In fact, almost 20% of all counties in the United States have no physical banking offices other than community banks. This represents a sharp urban-rural divide, ensuring that any change to the system could have major ramifications.

There’s another variable here that may be even more significant: These community banks, which technically have such a small footprint in the industry overall, currently hold 46% of all small loans to businesses.

If this is seen as a problem, is a two-tiered banking system the solution? It’s an interesting question that deserves extended discussion.

First, as the FDIC makes clear, community banks often succeed or fail for the same reasons as their larger industry counterparts (or even other businesses). The three main factors are distressingly familiar: too-rapid growth, an unjustified focus on commercial real estate lending and volatile funding practices. In effect, some banks made bad decisions and paid the price.

However, it should also be noted that the banking environment in 1984 (the ominous date cited in the FDIC report) was entirely different, one without online banking or mobile apps. As discussed in this blog frequently, many consumers no longer feel the need to go the neighborhood bank, since a basic smartphone can take them anywhere. Does this hurt community banks, or does it give them the ability to take on larger competitors more aggressively?

Moreover, does a two-tiered regulatory system imply that community banks will face fewer regulatory restrictions? Sen. Warren makes the case that small banks are subject to too many mandates that were written for their larger brethren, creating a fundamental unfairness that hurts some competitors.

Larger institutions could argue, however, that more regulations in effect penalize larger corporations for their success. After all, short of monopolistic concerns, shouldn’t everyone have to play by the same rules?

There are perhaps no easy answers here. But in the weeks and months ahead, as the economy continues to heal, the housing crisis works itself out and new technologies continue to emerge and stoke competition, it will be interesting to see how this debate plays out.